Making The Case For An Insurance Broker Review Of Hospitality Industry Loan Contracts

By Rob Johns from July 25, 2017

The insurance section of a mortgage-refinancing contract is no one’s idea of fun reading. And the legalese becomes even less appealing as the number of documents increases. Which brings us to hospitality industry operators, whose properties not infrequently number in the dozens (if not more). More often than not, such portfolios produce a never-ending stream of refinancing deals. And just as frequently, the legal review of such documents—whether conducted by in-house lawyers or outside counsel—is not focused on the insurance obligations of the parties because it is a rush to move the process along to sign off on “boilerplate” agreements and get the deal done.

But while such an approach is understandable, it is also unwise. Insurance professionals see risks, and the costs associated with ameliorating them, from an entirely different perspective than attorneys. Indeed, a broker review of the insurance sections of refinancing contracts should be seen as a best practice.

Failure to scrutinize these provisions could put a hotel, condo or restaurant operator in danger of sudden default—and may also result in higher premiums than necessary.

Consider this cautionary tale from one of Crystal & Company’s hospitality clients: A hotel operator was proceeding with what it assumed was a standard refinancing process, but an insurance-oriented review of the contract pre-signing revealed several non-standard issues. The lending bank, for example, was named as sole payee on property/casualty insurance. Moreover, in the event of a loss greater than a set amount, the lender had full discretion to use any claims money to pay down the mortgage. Despite being “covered,” in other words, our client would have been forced to pay for any rebuilding effort out of pocket.

Fortunately, our pre-signing review caught these red flags, and we suggested that the client renegotiate. They did, and, as a result, the signed contract contained an industry standard loss payee (which protects the bank’s interests without making them the sole recipient of that claim check) and raised the minimum loss to multiples of the initial bank demand at which the bank could use all claims reimbursement to pay down the loan.

But this is just one example of the kinds of insurance-section provisions that could easily pass legal muster but nonetheless presenting serious insurance challenges to operators. Others we have observed include:

Lenders insert insurance covenants that, if not heeded, could leave the borrower technically in default. For example, a lender could insert a new stipulation for more ordinance coverage, of which the borrower is unaware and therefore noncompliant with the contract;

Lenders “force-place” insurance—that is, they secure a policy that is both needlessly costly but limited in its coverage—and add it to the loan costs down the line; or

Lenders insist on unreasonable or unnecessary coverage—for example, flood and earthquake insurance for properties in area that don’t see either—solely because someone unthinkingly checked off a templated box.

The latter example illustrates the advantage that an experienced insurance professional brings to contract reviews. Although Crystal & Company would never recommend less-than-adequate coverage, we also aim to prevent clients from paying higher-than-necessary premiums. And we can help provide the client with the kind of argument that will persuade lenders to reconsider overly cautious positions. For example, we have in the past provided a lender with an independent report proving why a resort in the Southwest does not need extensive flood insurance. Indeed, even for properties located in an earthquake zone we have used descriptions of the types of soil in the area along with government data to analyze the Probable Maximum Loss for a specific address. Such proof can and does satisfy underwriters, allowing borrowers to buy less than maximum earthquake coverage and save substantially on premium payments.

Finally, there’s a more subtle benefit to including an insurance focus in any contract-review process. The knowledge gleaned by a sophisticated broker cannot help but make him or her that much better at understanding an operator’s overall business and particular risks. That learning, in turn, will influence a broker’s assessment of what a business must have by way of coverage—and what it can afford to pass up.